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Rules complicated for reinstating 401(k) contribution matching
Karen1

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Jul 08
2010

Speed bumps on the way to re-matched 401(k) pay-ins

Posted by Karen1 in safe harborhewitt AssociatesGrant Thorntondefined contribution plansCharles Schwab401k

Karen1

According to recent surveys by Fidelity Investments, Grant Thornton and Hewitt Associates, many of the companies that eliminated matching contributions to their employees' 401(k) plans now are slowly reinstating them, as Steve Taub wrote about last week. In Grant Thornton's survey from February, for instance, 20 percent of companies that eliminated or cut their matches already had restored them, while another two-thirds were planning to do so.

Reinstating a 401(k) match is great news for employees. The not-so-good news for employers? Complying with the myriad rules that come into play can get complicated, notes John Lowell, a vice president with Aon Consulting. Unfortunately, compliance and doing good by employees are "not always on the same page," he notes. 

 At the same time, many employers say that they're increasingly concerned about employees' abilities to fund their retirements, given the beating most account balances took over the past few years. While two-thirds of employers queried in 2009 were confident that their employees would retire with sufficient assets, only 54 percent were a year later, research by Hewitt Associates has found. So, along with restoring 401(k) matches, employers increasingly are turning to tools like automatic enrollment and rebalancing in order to boost plan participation.
 
Reinstating a 401(k) match gets particularly tricky for companies that want to return to a safe harbor plan. While the regulations get quite involved, in general, a plan is considered a safe harbor plan when the sponsor either matches 100 percent of employees' contributions up to three percent, and also matches 50 percent on the next two percent of contributions; or contributes three percent to the accounts of all eligible employees, whether they contribute or not. Safe harbor plans may be able to skip the Actual Deferral Percentage (ADP) and/or Average Contribution Percentage (ACP) testing that other plans must complete each year, as outlined in this summary from Lincoln Financial Group. About 30 percent of 401(k) plans meet safe harbor criteria, says David Wray, president of the ProfitSharing/401(k) Council of America.
 
While companies can return to a safe harbor design, they can't do so in the middle of the plan year, Lowell says. In addition, they have to provide notice of the design and safe harbor status at least 30 days before the beginning of the plan year. If these steps aren't followed, the plan will need to complete the ADP and ACP testing for the first year that the match is restored.
 
In addition, many plan sponsors that need to complete ADP and ACP testing use what's known as "the prior year method;" the other option is "current year testing." In the prior year method, the company examines the contributions from non-highly compensated employees (NCHEs) during the previous year to determine how much their highly compensated employees (HCEs) can contribute during the current year. However, because many of the companies that suspended their matches did so early in 2009, that may limit the amounts their HCEs can contribute to their accounts in 2010.
 
To be sure, a company is free to change its testing method. However, such a change generally is permitted only once every five years. As a result, this is not a decision to rush into, Lowell notes.
 
Another concern involves participation rates. Many companies that go to the trouble to restore their 401(k) matches also want to use the opportunity to boost participation, says Karen Dzurisin, an Indianapolis-based manager with Baden Retirement Plan Services. As she notes, the only factor that employees saving for retirement can control is the amount they, or their employers acting on their behalf, are saving. They can't control the markets, interest rates or tax levels.
 
The structure of a 401(k) match can make a difference in participation rates, Dzurisin notes. For instance, employees may be more likely to participate in the plan if the employer matches 100 percent of the first three percent of their contributions, rather than 50 percent of the first six percent. That's because employees may feel it's too difficult to save six percent, but figure they can save three percent. "It's very psychological," she notes.
 
On the other hand, a recent study from Charles Schwab found that plan participants contributed at higher levels when the match ceiling increased. For instance, when the ceiling was at 3 percent, only 45 percent of participants saved six percent or more. At companies that matched six percent of contributions, 60 percent of participants saved six percent or more.
  
Automatic enrollment is another participation booster. The average participation rate in 401(k) plans of about 75 percent increases to 80-plus percent for plans that automatically enroll employees, says Pam Hess, director of retirement research with Hewitt Associates.
 
Finally, employers need to get employees' attention, Hess notes. Messages like, "Employee A, you are giving up $5,000 each year in matching contributions," may be the spark some employees need to begin contributing.

The return to reinstatement is, of course, far from universal. And a small but growing number of companies moving in that direction are leaving themselves some wiggle room, says Wray. So, the company says it may or may not match employees' contributions in any given year, depending on the company's performance.
 
Most companies taking this route have gone through several suspensions and restorations of their matches over the past few years. From an administrative perspective, suspending and reinstating a discretionary match is less work than restoring a fixed match.
 
While Wray doesn't have statistics showing the percent of companies making this shift,  anecdotal evidence suggests that their ranks are growing. What's more, larger companies, along with smaller firms, are using this tactic, he says.
  

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